Recently while sitting at a table with strangers before works, people started talking about taxes. This is always a fun subject to talk about, mainly because most people have no clue how our tax system works. But why would you, its confusing.
The worst part of this discussion, in which I just sat and listened, people truly believed if they got a pay increase that moved them to a higher tax bracket, that they would bring home less money annually. FALSE.
Honestly the scary thing about this thought process, it creates complacency. I was sitting with people in the same class as the majority of Americans, and they believed trying to get promoted will generate less money. Complacency is scary and will halt all progression. We want people to desire promotions and professional development in order to enhance our workforce.
I do not want to write about changing our education system so we teach youth how the American tax system works, which is a huge part of life we need to understand. I would rather talk about the American tax system, what it is, how it works, and how you wont lose money getting that raise.
Marginal Tax Rates
Alright, this is usually what throws most people off. If you have a salary of $75,000 a year, this does not mean you are paying 22% right off the bat. The government does not tax you based on how much you are “suppose” to make, they tax you on how much you have made for the year.
Lets say a person is single and earning an annual income of $100,000. The person does not pay 24% on the entire annual income. They pay 10 percent on the first $9,525 earned; 12 percent on the income earned between $9,525 and $38,700; and 22 percent on their income from $38,7000 to $82,500. They only pay a 24-percent tax rate on the money they earn over $82,500. Make sense? You get taxed more throughout the year when you earn more money.
Why does understand marginal tax rates matter?
The reason this matters, you need to understand getting a pay increase will not lower your annual income. Even if you move into a new tax bracket. If you were to get taxed at a higher rate for the entire annual income, yes you would make less. But you only get taxed at that rate on the income over the new bracket.
Can you make less money annually with a raise: Some will make the argument about Earned Income Tax Credit, claiming a raise will decrease their EITC.
First off for those unaware what this is, here is how the IRS defines EITC “ The Earned Income Tax Credit, EITC or EIC, is a benefit for working people with low to moderate income. To qualify, you must meet certain requirements and file a tax return, even if you do not owe any tax or are not required to file. EITC reduces the amount of tax you owe and may give you a refund.”
A person’s EITC will decrease with the more money they make, but it decreases gradually. The decreases will never be so great that they will offset the increase in income a person would get from a higher salary.
Conclusion: Hopefully you have a better understanding of how your income is taxed by the federal government. The marginal tax system makes sure you do not lose annual income when you enter a new tax bracket.
Go out there and get that promotion! We all want more money for more toys… Or supplements? Your call.